This is China! blog

A Chinese friend told me this past weekend that one of her cousins recently took out a house loan and instead went on a buying spree on appliances and clothing and other amenities that included a new car. The cousin, apparently, has little interest in repaying the loan. Such, I suppose, is the quality of supervision of the flood of money still pouring out of China’s banks to “stimulate” the economy; and such, I also suppose, is the bank’s assumption that many of the loans will never be repaid – that is, they assume a sizable proportion of the loans will be Non-Performing Loans (NPLs). Add to that a financial system and judiciary so full of holes that it is very very difficult in China to reclaim bank losses. So, it seems the cousin may actually get away with the dough.

Hearing the story put me in mind of something Bill Bonner, author of the books Financial Reckoning Day and Empire of Debt, wrote a couple weeks ago in The Daily Reckoning blog :

But they were not creating wealth…they were consuming it. They were spending money they hadn’t even earned yet. In other words, they were not only consuming their current wealth, they were consuming wealth that didn’t even exist yet – it was tomorrow’s wealth. You couldn’t see this happening by looking at the GDP numbers; instead you had to look at balance sheets. And even then, you needed to look at them with a suspicious eye. On the one side, debt was clearly swelling up; it doubled during the 2001-2007 period. On the other, assets were swelling up too. But the assets were of the overpriced, Bubble Era variety…houses and stocks that were subject to easy correction. And when the correction came, assets declined…and debt grew heavier and heavier.

Bill was talking about the United States in that passage. But it sounds scarily like what China is doing today:

And here…perhaps we should pause. We are about to tell you that China is a scam. It’s not really becoming more prosperous. But before we do, we have to explain what prosperity really is…

Well, here’s a question for you: if China were really growing at 8% per year, how come its electricity consumption is going down?

Answer: Because the Chinese bureaucrats can jiggle and jive the numbers for employment, GDP, and inflation. But the number of kilowatt-hours consumed in China is just a number. It is not computed. It is not seasonally adjusted. It is not tortured by statisticians nor tormented by economists. It is just a number. And that number is a smaller number than it used to be.

Oh, and here’s another number. China’s exports for July were down 22% from the year before. Here’s another question: how can an export led economy grow when its exports are collapsing?

Add to all that deflationary pressures in China of 1.8% annually – which reflects a consumer that’s not buying as much as the government claims – and it would seem that the Chinese stimulus package to buck up infrastructure spending is not actually creating wealth, but is instead taking wealth from the future (by creating debt that will not be increasing the productivity needed to pay off the loans-plus-interest for a very long time to come). And with Chinese households taking on greater debt and speculating on the stock and property markets what cash they do have, it looks as though China will be in for a long hang-over after the party, during which it will have to make the sort of structural changes it hasn’t had to contemplate since it put millions of workers out of life-long jobs at State-owned Enterprises (SOEs) back in the mid-1990s.

Oooh, that’s gonna hurt.

An American friend who’s been living in the same condo in Suzhou for at least four years now has new neighbors. Actually, he’s not had any neighbors in several years. He lives in a corner condo in Suzhou Industrial Park, in a neighborhood with other expats, albeit Asian expats – Singaporean, Korean, even Taiwanese – make their homes. The landlord of the place next door introduced the American to the new neighbors by happenstance, as the neighbors were moving in: my friend happened to just be coming home from work at the time. The two new tenants are Mainland Chinese, engineers at a mainland Chinese factory in the Suzhou New District, across town.

Immediately my friend’s antennae went up: Mainland Chinese? Chinese-owned factory? Suzhou New District? My friend’s company pays several THOUSAND US DOLLARS each month to keep my friend esconced in luxury, American-style: American washer and separate dryer in the garage; American dish washer and refrigerator (American-sized, of course); and all the American TV stations a satellite dish can support.

So, he posed the question to us all round the table who were enthralled by the discontinuities in the landlord’s story: what would a couple Chinese engineers making several thousand RMB each month be doing living in a condo in an expat neighborhood? Maybe, he suggested, they’re not really engineers!

He suggested that the next time any of us ever come to his flat while he’s home and knock on the door, he may not hear us: he’ll be too busy with his ear against a drinking glass he’s pressed against the wall adjoining his neighbor’s new home. To gather some “intelligence” of his own.

That his life should be so exciting.

The Financial Times this past weekend printed a lively and insightful magazine article on the tastes of the nouveau riches in China called, “Shopping habits of China’s ‘suddenly wealth”. Chinese call the newly (and quickly) wealthy baofahu, a rough translation of which means someone who has rapidly become wealthy by suspect or even corrupt means. For a perfect example and explanation of what constitutes a baofahu and what your average Zhang thinks of her, check out the ChinaSMACK page entitled “Shanghai Car Show Rich Shanxi Girl Gives Money for Photo”.

The FT article is divided into six sections

• Rare animals
• Big cars, flashy cars
• Gold
• Barbie
• Spirits and fine wine
• “Penny pinching, ruthless, suspicious shoppers”

Some of the more disturbing buying patterns involve:

…traditional Chinese tastes, combined with the explosion in wealth during the past decade, have created a rapacious and unsustainable call for the body parts of endangered species. The manufacture of traditional delicacies, ornaments and medicinal ingredients has helped to cut swathes through populations of sharks, elephants, seahorses and other species across the world – and that demand is only expected to increase.”

And almost as criminal:

The cachet of ordering an expensive bottle also still far outweighs the pleasure derived from drinking it, and Chinese nightclubs are filled with wealthy people ordering top-shelf cognac then mixing it with gallons of sweet, green-tea-flavoured soft drinks.”

Been there. Done that. Bad idea.

The article also discusses how the buying habits of Chinese vary throughout the country, including the interesting tidbit that Zhejiang people like it rough – their toilet paper, that is.

Well-worth the read.

Recent visits to three Chinese provincial capitals in the interior of China have left me in awe of the pace and magnitude of property and infrastructure development. I felt my head spinning at the 24/7 pulse of activity in each of Chengdu, Chongqing and Kunming. Or perhaps it was just the air enveloping the cities, laced as the environment was with dust from the constant construction work and fumes from cars, trucks and buses. Nevertheless, it was easy to see that the Open-Purse Policy the Chinese leadership encouraged of its banks this year was clearly in high gear.

Chengdu, the capital of Sichuan, was far larger than I had anticipated, with broad avenues choked with traffic framed by construction cranes launching high-rises every other block. In general, the people were as relaxed and generous with conversation as I had heard, and the food was absolutely amazing. I did find, though, after several days in the city, it was a treat to find a restaurant where I could find food that was NOT spicey. The Bookworm bookstore and cafe was a welcome retreat from the frenetic pace of construction and traffic, and had a dynamite American-style breakfast on offer. I was surprised at the number of chic international retail outlets at the center of the city, and the expensive import luxury cars dumping wives and girl friends in front of the expensively decorated storefronts. And the bar street across the canal from the Shangrila Hotel was a fun outdoor venue from which to watch the crowds amble by, looking to be looked at. A group of local guys at one of the bars thought my haircut was pretty groovy and invited me to get as falling-down drunk as they were. Though I did join in, experience taught me how to lie convincingly enough I was able to escape with the contents of my stomach still intact.

In Chongqing I saw an old American friend and his wife on their penultimate day before returning to the States after they had worked in China nearly five years. I have a special place in my heart for Chongqing, its people, its roughed geography, its history and the Wild West approach to business the city takes. It had been about two years since I had finished a couple projects out that way, but I was instinctively able to steer to some of the places I had frequented in the past, and knew enough about the places I wanted to visit but hadn’t yet. One place high on my list was the Stillwell Museum, likely the only museum in China dedicated to an American. General Joe “Vinegar” Stillwell was the guiding force behind the Allied defense of China during World War II, and the architect and engineer of the famous Burma Road, which sliced a dangerous logistics route through South China, Burma and into India. It was truly inspiring to be in the house cum museum that had been his home and Allied headquarters in China until Chiang Kai Shek had him thrown out of China to save Face. Another inspirational retreat was the home of Chiang Kai Shek and his wife Soong Mei Ling (Madame Chiang), which was cleverly hidden amongst the forests shrouding the mountains ringing the modern city, a clever defense against the Japanese air raids that at one time made Chongqing the most bombed city in human history. Traffic in Chongqing was even more choked than in Chengdu, because of the narrow and sometimes hazardous roads that intersect like a bowl of soot-covered noodles.

I had been to Kunming, capital of Yunnan province, two years before, and was amazed to find it even more abuzz with construction and commercial activity than my first visit. Lee Perkins, a British expat and founder of China Intel Group, a market research company that has developed expertise in south China and southeast Asia, met with me for a few rounds of beers at a hangout I had developed a fondness for during my first visit, Salvador’s Cafe. Lee, who splits his time between Kunming and Beijing, told me how the massive construction/destruction project I had come across as I had exited the airport involved turning the city’s second ring road into an elevated pass; the city had just finished its third-ring road, and was intent on building its new international airport, after which they would tear down its current, dog-eared domestic airport. One of the things that struck me strongest while strolling through the exhaust-choked streets of the city was how many high-end luxury shops from Italy and France and Switzerland had popped up in just two years, and how many more chic high-rise malls were under construction.

One of the biggest differences I noted upon each of my returns from the deep south to my hometown Suzhou, near Shanghai, was that I did not see any fights or even arguments in the streets of the landlocked cities. Literally, within three days of returning to Suzhou I saw two fights in broad daylight that drew large, highly entertained crowds.

Still, there’s no place like home.

BusinessForum China Magazine mid-summer published my article on the Services Outsourcing Industry in China. Entitled, “Out of Bangalore and into China,” I discuss the social and economic drivers, and government subsidies and policies promoting what Central government has deemed a pillar sector. One of the best things about the article is its placement in a particularly outstanding issue of the magazine, published by the German Chamber Network in China. Articles I found must-reads included:

• A Tectonic Shift: What Will China’s Role be in the World’s Future Financial Set-up?
• The China Price is Unsustainable, an interview with the author of the book, “The China Price”
• Monetary Flows:  Chinese Foreign Investment – How Much and Where (Part 2 of 3)
• Place Your Bets, about China’s real estate bubble

It’s a timely and relevant issue well worth checking out.

The New York Times recently linked together several publicized decisions the Central leadership in China has made that indicate the country is beginning to realize the responsibilities that come with its growing economic power:

… the World Trade Organization has rebuffed China in an important case involving Chinese restrictions on imported books and movies. The Chinese government dropped explosive espionage charges against executives of a foreign mining giant, the Anglo-Australian Rio Tinto, after a global corporate outcry. And on Thursday, the government said it had backed off another contentious plan to install censorship software on all new computers sold here.

Now, it’s tougher with China’s successes for it to cry that the colonialists are out to hobble it. In other words, it’s signed up to trade obligations that helped make its economy what it is today, and it’s going to have to honor those obligations or find itself taking a few steps backward as it has the several times in the last twenty years when it fobbed its collective nose at the rest of the world..

“Fifteen years ago, the mantra in China was, ‘We’re the victims of a system that’s stacked against us,’ ” said James V. Feinerman, an expert on Chinese law and policy at Georgetown University in Washington.

China’s entry into the world trading system, he said, is slowly helping to change the nation’s view of itself from that of an outsider to an insider with a stake in the global system’s success.

Read more here…

China is in a bind trying to deflate its asset bubbles in the stock market and in property. By buying dollars to force the Yuan’s peg to the dollar, Beijing closes one of the few doors it has to cooling hot-money inflows into China. Simon Johnson, an economist, writes a straight-forward and cogent explanation in last week’s New York Times for why the world is so interested in investing in China right now and how too much money can sometimes be more a headache for the leadership than not enough …

The world’s financial markets have decided that Asia is rebounding more quickly than most other parts of the world, and capital is rushing to get into those countries before asset prices rise too much…

The monetary policy authorities know this and — given what we have all seen in the last few years (or is that two decades?) — they are rightly worried about new “bubbles” of various kinds that can destabilize their financial systems and undermine their economies.

But what should these central banks do? If you fear that your economy is growing too fast, and inflation is on the rise, central bank mantra dictates that you should raise interest rates. The same mantra was, in the era of Alan Greenspan, less clear on whether interest rates should be increased to forestall unsustainable financial bubbles. With the puncturing of the Great American Bubble, including the fall of Mr. Greenspan as an icon, most central bankers are quietly willing to tighten monetary policy if they see real estate prices take off.

But this is exactly where the problem lies.

If you raise interest rates in an economy open to capital flows, at the same time as the world’s money centers have low or almost zero interest rates, what happens?

Almost certainly, you will attract more capital from overseas. This capital inflow will likely feed into your domestic credit boom and further the run-up in asset prices, housing construction and other bubble-related phenomena.

Read more…

Andy Xie, a well-known independent economist based out of Shanghai, recently wrote a lengthy and lucid account of how the current asset bubbles in China (stock market and property) developed, how they’ll be pricked, and the effects of the bubbles on China’s future short-term and long-term prospects economically and socially.

The most serious damage that a property bubble inflicts is in changing demographics. High property prices bring down birth rates. When property prices decline after a bubble bursts, the low birth rate culture cannot be changed. Hong Kong, Japan, Korea, and Taiwan all went through property bubbles during their development. Their birth rates dropped during the bubbles and didn’t recover afterwards despite government providing incentives. China’s one-child policy alone will lead to a demographic catastrophe in two decades. The property bubble makes the trend irreversible: when the government abandons the one-child policy, there wouldn’t be meaningful impact on birth rate. Within two decades Chinese population could be very old and declining. Of course, property prices would be very low and declining also.

Richard McGregor at the Financial Times writes how the bubbles will affect China’s change in leadership in 2012 – the same year Mr Xie expects the Big Bubble to burst.

Meetings finished for the day in Shanghai and a couple hours to go until I had to take the bullet train back to Suzhou, I decided to check out the Salvador Dali exhibit at the Shanghai Art Museum. And I’m glad I did!

In addition to his painting “The Persistence of Memory,” they did have lots of other artwork of his there with melted clocks. For Dali, in his obsession with dreams and symbolism, melted clocks symbolized the fluidity and malleability of time. Time as illusory, really. So, we see a Statue of Liberty-esque woman with a melted clock slung over her arm, a horse saddled with a melted clock, and melted clocks peppering various sketches. Dali was also obsessed with crutches (usually supporting some grotesquely overgrown limb), unicorns, vaginas and penises. Lots of penises.

The left side of the exhibition (as you enter the main foyer) is devoted to his religious and mythological work, as well as a section on “Lust and Women”, while the right side predominantly to his dream symbologies. I very much more enjoyed the mythology side of the Hall, as it devoted a sizable portion of the exhibit to his paintings and sketches from stories in the Old Testament and Dante’s Divine Comedy. Of course, Dali’s vision of the Inferno (Hell) is far more inventive, grotesque and enthralling than either Purgatory or Heaven, as is the case with the literary work itself. Why does the devil get to get all the fun, after all?

Some of his more risque work involved lithographs inspired by the works of the Marquis de Sade, with sketches of human beings contorted in the most inhuman poses doing naughty things to each other.

His sketches based on the 1967 poems of Mao Zedong were interesting in the sense that central to every picture was the idea of one man against either a massive giant or a horde of people or herd of horses. Sounds like Dali nailed that personality gestalt just right.

It was all good fun and well worth the 20RMB it cost for entry – plus the cost of the sketchpad and watercolor pencils I couldn’t resist buying in the Museum store. Keep an eye out for my own retrospective sometime in the future. Posthumous, of course.

The powers that be have made it plain they will spend whatever it takes to reach the magic 8% annual GDP growth rate in 2009. But how does China actually measure its GDP, and why should the world care?

The Financial Times raises the question, and a lucid and well-written article by John Makin at the American Enterprise Institute provides some answers. China’s definition of GDP growth and America’s definition are starkly different, which has thrown into question the efficacy of China’s approach to stimulating its economy and measuring the impact of the of its US$560 billion package. America measures its growth (or decrease) in wealth (Gross Domestic Product) by guaging expenditure growth: defined as the sum of consumption, investment, government spending, and net exports. China does just the opposite: the Chinese Central government – still stuck in the soviet-style mindset of production-as-reality at all costs – measures production activity without taking into account inventory stocks or actual expenditures. The form of measurement is one of the reasons for China’s bloated State-owned enterprises and for some of the economic disasters in its very recent history.

So, if a sneaker company in Guangdong produces a hundred pairs of sneakers with an attached value of RMB 6,700 (about US$1,000 in 2009 currency), then the Chinese government tracks the value of the shipment as part of its GDP statistics; whereas the United States government measures the expenditure on the shoes plus the value of any remaining inventory. For China, this way of measuring growth in its economy reflects some level of reality so long as buyers are buying all that is produced. However, as was the case in the economic downturn of 2008-9, buyers in other countries dried up. So, the Chinese government encouraged export-driven factories to begin selling to Chinese consumers inside the country. However, the spending power as well as the appetite of Chinese consumers, though growing between 10% and 15% per annum, was far from the easy-spending Americans and the more frugal Europeans.

Makin writes in his article, “China: Bogus Boom”:

There are anecdotal reports of Chinese households buying washing machines that were aggressively shipped and counted as retail sales during the first half of the year. However, many of the households that purchased washing machines, or were virtually given such machines, have found them unusable because their homes lack either the running water or electricity (or both) necessary to make use of a modern appliance. Such problems arise when ambitious planners count shipments as retail sales while end-use demand may be absent. In such cases, the “sales” are made to happen by virtually giving away the products that have already been produced and counted as GDP growth.

So, to give the perception that China’s economy was actually on its way to meeting its 8% growth rate, it told the four largest banks in the country – all of which are State-owned – to open up lending specifically to State-owned Enterprises and to local governments for infrastructure projects. It didn’t matter whether the companies or governments produced anything with the money, or even how they spent it if they did, since the release of funds in and of itself would register as production in the Chinese economic view. In other words, the only thing that mattered was that the transaction itself would be registered as growth in GDP and – the powers that be hoped – encourage Chinese consumers to spend because the economy was outperforming other economies in the world.

The flood of money has already resulted in dubious projects appearing on the schedules of local governments. The Washington Post wrote:

A $3 billion metro rail system linking the southern manufacturing cities of Guangzhou, Dongguan and Shenzhen, for instance, has been criticized as a waste of money because there are already four railway lines linking the cities and the trains often run empty. Ditto a $4.5 billion highway connecting the Sichuan province cities of Chengdu, Zigong and Luzhou, because there are already highways from Chengdu to Zigong and from Zigong to Luzhou.

A bridge running from just outside Shanghai to a textile manufacturing center on the other side of a bay was also resurrected to create construction jobs. For years, its designers had been unable to get the $2 billion they needed to build it because its route would mostly duplicate that of another massive bridge that was already under construction.

That changed in November when at least six of the biggest employers at the other end of the bridge, in Shaoxing, went out of business. Even though there is less need because of the closures, blueprints for the second bridge were dusted off and, almost overnight, workers broke ground. The project is expected to employ about 250,000 people and indirectly provide jobs for 300,000 more.

Which, of course, is the most important goal of any economic initiative in China: to provide opportunities for its citizens to be able to make at least a modicum of living, if not actually be able to become wealthy one day.

Monies the State-owned enterprises and local governments have not yet slated for projects are flowing into the real estate and stock market bubbles the government had worked to deflate as late as last summer (2008). As Andy Xie, an independent economist, wrote for Caijing Magazine recently:

“The tough economy and easy credit conditions encouraged many companies to try profiting from asset appreciation. They borrowed money and put it into the stock market. And since China’s stock market has risen 70 percent since last November, many businesses feel vindicated for focusing on the asset market. This speculation spread to Hong Kong. Mainland money may have been behind a recent rise in the Hang Seng Index to 19,000 from 15,000, as well as Hong Kong luxury property sales. One way or another, it seems the money source was China’s lending binge.

Borrowing money for asset market speculation is not restricted to private companies. State-owned enterprises (SOEs) appear to be lending money to private companies at high interest rates, i.e. loan sharking, using money borrowed at low rates from state-owned banks. Of course, we can’t estimate the magnitude of such SOE lending. But it has replaced high interest rate financing in the gray economy.”

Even with the prospect of the asset bubbles bursting, I believe China will continue to bolster liberal lending policies to at least give the appearance to the rest of the world that China is actually creating wealth in its economy. What it is actually doing, though, is just pushing money around. The stock market will for the forseeable future remain the purview of the SOEs, shielded by inadequate transparency and restructuring of listings. Further, China is long way off from providing investors with additional, internationalized outlets for investment beyond buying domestic property. And then, the long-awaited return of the American buyer as saviour of China’s export sector will be a chimera, never to return in its original form and enthusiasm. The government will find tamping down the bubbles will be even more difficult to achieve than before. Inflation will have to be tamed by fiat, just as had been the case with electricity and oil in early 2008. However, the Yuan just might come down to a more sensible valuation, because China’s fundamentals will seem so out of whack with the economic statistics it presents the world.

Oh, that Crazy 8.